Two important questions to ask before you buy Air China Limited (HKG:753) is, how it makes money and how it spends its cash. What is left after investment, determines the value of the stock since this cash flow technically belongs to investors of the company. Today we will examine Air China’s ability to generate cash flows, as well as the level of capital expenditure it is expected to incur over the next couple of years, which will result in how much money goes to you.
What is Air China’s cash yield?
Air China generates cash through its day-to-day business, which needs to be reinvested into the company in order for it to continue operating. What remains after this expenditure, is known as its free cash flow, or FCF, for short.
The two ways to assess whether Air China’s FCF is sufficient, is to compare the FCF yield to the market index yield, as well as determine whether the top-line operating cash flows will continue to grow.
Free Cash Flow = Operating Cash Flows – Net Capital Expenditure
Free Cash Flow Yield = Free Cash Flow / Enterprise Value
where Enterprise Value = Market Capitalisation + Net Debt
Air China’s yield of 4.67% indicates its sub-standard capacity to generate cash, compared to the stock market index as a whole, accounting for the size differential. This means investors are taking on more concentrated risk on Air China but are not being adequately rewarded for doing so.
What’s the cash flow outlook for Air China?Does Air China’s future look brighter in terms of its ability to generate higher operating cash flows? This can be estimated by examining the trend of the company’s operating cash flow moving forward. In the next few years, a growth of low single-digit 4.1% isn’t exciting, but it may be adequate, so long as capital expenditure doesn’t ramp up by even more. Below is a table of Air China’s operating cash flow in the past year, as well as the anticipated level going forward.
|Current||+1 year||+2 year||+3 year|
|Operating Cash Flow (OCF)||CN¥31b||CN¥32b||CN¥30b||CN¥33b|
|OCF Growth Year-On-Year||3.0%||-8.6%||11%|
|OCF Growth From Current Year||-5.9%||4.1%|
Four words – low yield, negative growth. Air China doesn’t jump out to me as an exciting new investment for you. If you buy the stock, you’re taking on higher risk relative to holding the market index, and further, you are being compensated for less. Now you know to keep cash flows in mind, I recommend you continue to research Air China to get a more holistic view of the company by looking at:
- Valuation: What is 753 worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether 753 is currently mispriced by the market.
- Management Team: An experienced management team on the helm increases our confidence in the business – take a look at who sits on Air China’s board and the CEO’s back ground.
- Other High-Performing Stocks: If you believe you should cushion your portfolio with something less risky, scroll through our free list of these great stocks here.
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.